IPO Preview: Select Income REIT

Based in Newton, Massachusetts, Select Income REIT (NYSE:SIR) scheduled a $176 million IPO with a market capitalization of $660 million for Thursday, March 8, 2012 at a price range mid-point of $22.

SIR is one of five IPOs scheduled for this week (see our IPO calendar).

SUMMARY

68% of SIR's revenue comes from mostly land leases in Hawaii, which are reset periodically.

Spin-off

The parent, CommonWealth REIT (CWH), will receive a total of $400 million cash, including all the IPO proceeds and $250 million of debt it laid on SIR as part of the spin-off. CWH retains 73% which at the price range mid-point would be valued at $482 million.

CWH will net $882 million from the transaction, not bad for a REIT with a market value of $1.6 billion

SIR is offering a 7.3% annualized return at the price-range mid-point. In 2012 the payout is expected to only 75% of cash available for distribution, which leaves room for a payout increase down the road.

OBSERVATIONS

Most of SIR's revenue comes from land leases in Hawaii, which generates 68% of revenue.

Since CWH acquired SIR's Hawaii properties in 2003 and 2005, many of SIR's Hawaii land leases have had at least one rent reset, resulting in a rent increase, on average, of 30.3% over the rent being reset.

A significant number of SIR's Hawaii land leases are scheduled to have their rents reset in the next four years.

A 7.3% payout is not particularly high for a REIT in the current market. For example, see below other properties which are managed by the same CWH group.

CONCLUSION

If an investor is income-oriented, we believe SIR could be a good long term investment based on its mostly secure income stream, and on prospects for a payout increase over time.

However, we expect SIR to be flat to perhaps down on its IPO, depending on the pricing.

Here are some comparisons with CWH the parent and other REITs managed in the CWH family.

BUSINESS

SIR owns 251 properties with a total of approximately 21.4 million rentable square feet. Two hundred and fifteen of the properties are commercial lands in Oahu, Hawaii totaling 17.4 million rentable square feet.

Hawaii properties contribute 68% of revenue

SIR also has four easement properties in Oahu, Hawaii, under which SIR has granted third parties the right to use a portion of certain properties in exchange for regular payments.

Fourteen properties are located in seven states (Alabama, Arizona, California, Kentucky, Massachusetts, New York and Texas) and include 1.5 million rentable square feet of office space.

Nine properties are located in seven states (Connecticut, Florida, Iowa, Ohio, Pennsylvania, Texas and Virginia) and include 2.2 million rentable square feet of industrial and warehouse space.

Property Operations

As of December 31, 2011 and 2010, 95.3% and 96.3% of the total rentable square feet of SIR's properties was leased.

Average effective rental rate per rentable square foot was $5.32 in 2011 and $5.08 in 2010.

RENTAL INCOME INCREASE IN 2011

The $10.8 million increase in rental income includes $8.1 million of rental income from five properties acquired between December 2010 and January 2011, $1.7 million related to increases from rent resets at properties located in Hawaii and $1.0 million related to other leasing activities, including lease renewals and new leases throughout the portfolio.

REIT

To qualify as a REIT, SIR must distribute annually at least 90% of REIT taxable income

Because of SIR's net lease structure, high occupancy and weighted average remaining lease term, SIR believes its cash available for distributions, is reasonably secure.

PAYOUT

SIR's expected initial quarterly distribution is $0.40 per Share, or $1.60 on an annualized basis, which is a 7.3% return at the price range mid-point of $22.

As of December 31, 2011, the weighted average remaining lease term of leases (based on annualized rents) was 12.2 years.

HISTORY

SIR is currently a wholly owned subsidiary of CWH, a NYSE-listed REIT that owns office and industrial properties with a historical cost of $7.8 billion.

CWH created SIR to concentrate its ownership of certain net leased lands that CWH purchased in 2003 and 2005 from the Damon Estate and Campbell Estate, respectively, in Hawaii and single tenant office and industrial properties. CWH's current business plan is to focus its investments on multi-tenant central business district, or office buildings.

On February 16, 2012, CWH contributed 251 properties to SIR. In return, SIR issued to CWH 22,000,000 Shares (including the 1,000 Shares initially issued to CWH) and a $400 million demand promissory note.

SIR will use the net proceeds of this offering to repay part of the $400 million CWH Note. SIR expects to repay all of the remaining outstanding balance of the $400 million CWH Note with borrowings. The bank facility that will become effective upon completion of this offering.

Also, upon completion of this IPO, SIR will reimburse CWH $2.4 million for costs it incurred to organize and prepare for this offering.

GROWTH PLAN

Internal growth prospects

A majority of SIR's Hawaii properties are lands leased for rents that are periodically reset based on fair market values, generally every five or ten years.

Since CWH acquired SIR's Hawaii properties in 2003 and 2005, many of SIR's Hawaii land leases have had at least one rent reset, resulting in a rent increase, on average, of 30.3% over the rent being reset.

A significant number of SIR's Hawaii land leases are scheduled to have their rents reset in the next four years. The leases for a majority of SIR's other office and industrial properties include contractual fixed rent increases applicable during their remaining lease terms.

External growth prospects

Post-IPO SIR expects to have $252.5 million available under its bank facility.

SIR believes that there are significant opportunities to acquire net leased, single tenant properties, especially in suburban areas, and that there is limited competition from well capitalized investors for such properties at this time.

TOURISM

SIR is significantly affected by Hawaii's economy. Hawaii's economy is heavily influenced by tourism. A

MANAGEMENT

SIR has no employees. Personnel and services that we require will be provided to us under contracts with RMR.

In management agreements with RMR, SIR acknowledges that RMR manages other businesses, including four other NYSE-listed REITs (CWH, GOV, HPT and SNH).

USE OF PROCEEDS

$160 million allocated to pay newly incurred debt to the parent, CWH, which will own 73% of SIR's stock assuming no over allotment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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